Golden Era of Equity Crowdfunding Takes Shape — Slowly

The unlikely media hit of the past fall was Serial,
a podcast that tells the story behind the 1999 murder of a
Maryland teenager. The runaway success of Serial,
which averaged some 1.5 million listeners a week and was
downloaded more than 5 million times, has prompted excited talk
of a golden age for podcasting. But the renaissance in podcasts
has also highlighted, in parallel, the emerging golden age of
crowdfunding.

The more interesting podcast of the fall in that sense was
not Serial, which leaned on listener donations to fund
itself for a second season to be aired next year, but
StartUp, in which Alex Blumberg, an ex-producer for
NPRs This American Life, chronicled his efforts
to build and finance a start-up devoted to innovative podcast
programming. Having secured just over $1 million through angel
investors, Blumberg turned to Alphaworks, a New Yorkbased
crowdfunding platform, in the fall to help seek financing from
the podcasts rapidly growing follower base.

The firm helped Blumberg raise $275,000 in three hours from
36 investors, most of whom had only become aware of his
start-up through listening to the podcast about its fundraising
efforts. Those numbers sound impressive, but theres still
a long way to go before the bold new era of crowdfunding
reaches its full potential.

Alphaworks, which launched earlier this year with backing
from prominent venture funds such as New Yorks Lerer
Hippeau Ventures, is part of a thriving network of
capital-raising outfits designed to take advantage of
relaxations to private company funding mandated by the 2012
Jumpstart Our Business Startups, (JOBS) Act. That legislation
was passed in the aftermath of the financial crisis against the
backdrop of a shift toward companies delaying going public,
largely to avoid the reporting burden and relentless scrutiny
associated with the Sarbanes-Oxley Act of 2002 and the
Dodd-Frank Wall Street Reform and Consumer Protection Act of
2010.

The JOBS Act has accelerated this process by raising the
limit on the number of shareholders that companies are allowed
to have before theyre forced into the public market. As
entrepreneurs delay initial public offerings or resist them
altogether, the sheer size of the biggest private companies is
expanding rapidly. The old rule of thumb was that any
corporation with a valuation greater than $1 billion was ready
to go public, but today there are more than 50 private U.S.
businesses in that category  and few if any of them have
expressed an intention to float public stock.

The growth of private companies has in turn fed, and been
fed by, an incoming wave of new participants looking to fund
start-up ventures. Private company funding used to be the
exclusive province of venture capital firms, which owned
the whole thing, says Howard Lindzon, co-founder and
chairman of StockTwits, a New Yorkbased social media
network for sharing investment ideas. They used to be in
complete control of that world, Lindzon adds, from
incubating start-ups to helping them grow and shepherding them
toward an exit, via the public market or through an
acquisition. Thats not the case anymore.

Venture capitalists are still major players in the equity
funding landscape, but they now have to contend with new
entrants at either end of the cycle. Angel investors, many of
them organized into syndicates through platforms such as
AngelList, and incubators provide much of the seed capital for
early-stage ventures; the late funding rounds are dominated by
mutual funds, hedge funds and sovereign wealth funds, the
biggest of which manage far greater asset pools than even the
most well-capitalized VC firms. Several large public
corporations, spanning the gamut from Google to General Mills
and Walgreen Co., also now have venture funds to invest in
start-ups.

Crowdfunding, as envisioned by the JOBS Act, was designed to
open private markets to the ordinary retail investor, who has
seen
opportunities for public markets investment dwindle as
companies stay private longer. Offerings such as the
StartUp deal show that the ordinary investor
should have the opportunity to create value, says
Alphaworks chief executive Erin Glenn. But we are just at
the beginning of unlocking the promise of the act, Glenn
notes. Some portions of the JOBS Act were self-operative and
came into effect immediately upon its passage through Congress,
but the Securities and Exchange Commission is responsible for
writing the final rules under Titles III and IV, the parts of
the statute setting out the meat of how ordinary investors can
put their money to work as part of a crowdfunding effort.

Alphaworks helped StartUp raise $275,000 by
appealing to accredited investors, individuals who make more
than $200,000 a year or have at least $1 million in assets.
For individuals to come in and invest in a small start-up
 that becomes a retail ownership strategy just like you
have in the public markets, argues Glenn. Estimates of
the number of accredited investors in the U.S. vary,
though most put the number at more than 8 million people.

Accredited investors are covered under Title II of the JOBS
Act, which is already in effect. Title III, however, has been
stuck at the SEC since the act passed in 2012. These delays
have been very frustrating for investors who want to get
involved in this space and for entrepreneurs who want greater
access to capital, says Anna Duning, program manager at
Engine, a San Franciscobased start-up lobbying group
pushing for faster action on Title III. The SEC has already
released draft rules for its remaining responsibilities under
the act, but earlier this month the commission set out a
rule-writing agenda that suggests the final rules will not be
set until late 2015.

The SEC faces a tough balancing act in getting the rules
right. On the one hand, the act aims to open up new avenues of
capital and investment for businesses and ordinary Americans.
On the other, early-stage venture investing is risky, and
investors require protection from a field in which liquidity
and information are often scant.

In start-up and crowdfunding circles, the fear now, as
rule-writing gets pushed back further, is that the SEC may meet
its investor protection mandate so assertively that the
disclosure requirements start-ups are forced to go through will
be onerous enough to put them off from seeking nonaccredited
investor crowdfunding altogether. Clearly, investors need
to be educated, but we live in an era where individuals go out
and vote and we have more access to information than ever
 its a Big Brother attitude to say individuals are
not smart enough to make these decisions, Glenn
asserts.

Some entrepreneurs and crowdfunding firms are now pinning
their hopes on the acts being sent to Congress for a
rewrite. That could get around some of the restrictions placed
on the process by the SEC. But Engines Duning concedes
that even though the original legislation had overwhelming
bipartisan support, theres currently no critical mass
agitating for a rewrite.

Alphaworks raises money for start-ups that have already
received funding from angel or venture funds. Most crowdfunding
portals have taken a similar approach, with some now
co-investing alongside established venture funds. They mainly
play in the seed stage, with capital gathered from accredited
investors. But despite their frustration over the slow pace of
JOBS Act rule-writing, theyre setting themselves up for
the day when a much broader class of investors is able to
participate in this world, and there are signs that start-up
operators have already begun to think carefully about how they
can meet the need for ordinary investors to be better educated
about private companies.

I agree with the notion that its dangerous for
folks in the mainstream to start investing in companies when
theres no information available, says Bastiaan
Janmaat, co-founder and CEO of DataFox Intelligence.
Janmaats Mountain View, Californiabased start-up
uses natural language processing software to gather and curate
news and data  much of it disorderly and unstructured
 on investable private companies. Most of DataFoxs
customers are institutional market participants such as angel
funds and corporate venture funds, and Janmaat recognizes that
the vision of start-ups funding themselves via the crowd of
ordinary investors is still all very theoretical at this
point.

But the next year could bring that vision one step closer to
reality. And the success of StartUps Blumberg in
raising funds quickly from a group of established followers
suggests that eventually, once the JOBS Act takes full form,
start-ups user and funding bases may grow
coterminously.

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